Analysis originally published in the EUobserver 13.12.10
But if what needs to happen cannot happen, what does Lord Skidelsky, a 71-year-old economic historian who has been witness to the full fifty years of European integration, think will?
“I don’t think immediately, but the most likely outcome is that some countries will have to devalue, which means leaving the eurozone. Germany’s domestic policy doesn’t allow any other option.”
“What I don’t know is whether the initial thrust for this will come from a Germany where people are fed up with bail-outs or from the peripheral states where people are fed up with continuous austerity.”
Not that he thinks the eurozone will disintegrate entirely, but rather splinter, into two euros: perhaps between the core – Germany along with other surplus member states such as the Netherlands, Austria and perhaps Finland – on the one hand and the periphery on the other. Although it is an open and important question as to which side the others in the eurozone, France, Belgium and the rest, will fall.
Costas Lapavitsas, a Greek economist with the University of London, is of a similar mind: “Ireland must come to the realisation that being in the Eurozone with its current structure is a trap. It offers no option to the country other than austerity.”
“The response must be radical, in both Greece and Ireland, and probably the rest of the periphery of the Eurozone. They simply cannot handle the present scale of their debts and must default.”
However, going further than Skidelsky, he hopes that the break will come from within the peripheral states themselves rather than being booted out by Germany so that any restructuring or default – and the conditions that are attached – are set by the debtors rather than the creditors. If default is creditor-led, he argues, the required significant reduction of debt would be highly unlikely as creditors would ensure that their losses were as minimal as possible.
Lapavitsas again: “Of course the issue of membership in the euro will be put on the table and will have to be considered. But this might be an opportunity for a profound shift in the direction of economic development away from the disastrous road of the past.”
He notes that in 2001, when Argentina in a similar sovereign debt situation, with its peso pegged to the dollar, decided to suspend payments on its entire $144 billion public debt and abandon the dollar peg, the sky did not fall.
Initially the fall-out was severe: GDP declined by 11 percent in 2002, but the economy rebounded rapidly. From 2003 to 2007, GDP per capita maintained a growth rate of 8-9 percent annually. The bogeyman of being cut off from capital markets also never materialised. In 2006, when international debt markets to the country were re-opened, Argentina sold $500 million worth of bonds.
In 1999 in a similar situation, Russia defaulted on its external debts with an accompanying rapid devaluation of the rouble, but here it took only months for the economy to return to growth.
More recently and closer to home, in 2008, Iceland’s devaluation was as violent as the eruption of Eyjafjallajökull, and yet the country is now returning to growth once more.
The Greek economist does not counsel this option lightly, saying that there would be “serious implications” for such a policy shift: for a period, economic output would likely decline and unemployment would rise. Additionally, those with home mortgages taken out from foreign banks would see their personal debt levels skyrocket. There would have to be supplemental measures introduced to protect these households.
As a result of all of these dangers, “It is essential to have a frank public debate” over the costs and benefits of the move. Citizens would have to be the ones that consciously chose this path, fully informed and cognizant of the difficult days that lay ahead.
Such a shock to the EU system, he reckons, might anyway even jolt everyone into realising that the ‘good euro’ option, the radical leap toward a federal system that benefitted all member states, is necessary.
There are some additional concerns however, as the case of the European periphery, is not identical to that of Argentina, Russia or Iceland.
Argentina’s peso actually physically existed. The peso was only pegged to the dollar. But the drachma does no longer. So the costs of re-introducing these currencies as well as new software and cash machines, let alone producing new notes and coins, would be substantial.
And all of this only works if you are the only one devaluing. If everyone else does too, it doesn’t work. If the entire periphery spun off with its own ‘Mediterranean euro’, or worse yet, they each devalued independently, would this create a fresh European crisis of competitive devaluations? This was one of the problems the euro was created to solve.
Deutchmark Mark II
Whisper it, whisper it, but there are a number of economists in Berlin and Frankfurt who also believe that splintering the euro might not be such a bad option. However, for them, it is better that it not be Greece or Ireland that leaves the single currency first, but Germany.
There are two main ways the euro could splinter. But the crucial thing to understand is that Germany leaving the euro and re-adopting the deutschmark while the periphery stays in the euro is not the mirror image of the periphery leaving the euro and Germany staying inside. These two may seem to be opposite sides of the same coin, but they are not.
Turning the clock back again, when it was being decided who would qualify for EMU – economic and monetary union – Germany had originally favoured a euro composed of just northern economies. Paris, with its looser approach to budget deficits, worried this would put Berlin in the driver’s seat and so ensured that the southern states would be able to join, easing the pressure on itself.
The economists that favour a return of the deutschmark – or a ‘deutsch-euro’, if Austria, Finland and the Netherlands go off in a huff with the leader of the pack as well – are nostalgic for this never-was arrangement. Instituted today, it would see the ‘D-Mark Mark II’ sharply appreciate. Inflation risks would decline and the ‘solidarity duty’ to transfer funds southward would dissolve. Germany’s own euro-denominated debt – and Germany is pretty indebted itself – would become easy to dispose of, producing a windfall for both government and enterprise.
“And there would be other compensations: pensioners could retire to Spain and live like kings,” as financier George Soros pithily noted about this option when he wrote about the eurozone crisis in the New York Review of Books this August.
But the drawbacks outweigh the advantages, as Soros, who does not at all favour a return of the deutschmark, points out. Germans would quickly feel what it is like to be stuck with an overvalued currency and its accompanying rise in unemployment. The D-Mark Mark II boosters however counter that this is not a foregone conclusion, as demand for quality German machinery is pretty inelastic (minus the jargon: a change in price has little effect on how much of the stuff folks want to buy), eastern labour would become even cheaper and euro-priced assets would become as cheap as an empty shoe box.
The periphery would benefit as well, although only in a highly limited fashion. If they collectively stayed in the euro while Berlin left, the cost of paying back the euro-denominated debt they owed to Germany would be moderately reduced as the reborn D-Mark climbed. At the same time, the debt does not disappear, so the periphery remains handicapped.
But if it is Germany that stays in the euro and the periphery that exits, either individually or collectively, then the cost to the periphery of its euro-denominated debt does the opposite: it soars, which is why euro exit absolutely must be twinned with default for the periphery to benefit.
The German government will try to prevent this option – exit and default – at all costs because this would entail massive losses for its banks, losses that would then require massive injections of public cash, a la Ireland, turning Europe’s economic powerhouse into its own sovereign debt basket-case as private debt is again transferred to public accounts.
And the main purpose of this entire exercise is to save the big banks of the core of Europe.
In any case, we cannot ignore the political ramifications of either option. Both moves would inevitably kill the single market, and what is the EU without its single market?
As Soros puts it: “It is extremely unlikely that Germany would be allowed to leave the euro and to do so in a friendly manner. Germany’s exit would be destabilising financially, economically, and above all politically. The collapse of the single market would be difficult to avoid.”
The political destabilisation would be profound, not least because there are countries between core and periphery, most notably France.
The Franco-German partnership would instantly be over.
France’s economic interests have long diverged sharply from those of Germany. Unable to bridle its workforce in the way that Germany can, Paris requires a looser monetary and fiscal policy. This is both for structural reasons – it has no eastern fringe that can be used as a disciplining force (German boss to German workers: ‘Lads, if you don’t back off on your demands, I might just have to move the factory to Bratislava!’); and for domestic political reasons – the country’s unextinguishable labour militancy (French boss to French workers: ‘Lads, all right, all right! Stop boss-napping me and tying me up in the canteen toilet and I’ll give you your raise.’)
This divergence has always been a problem, but a politically manageable one. But now, if you take the so-called PIIGS economies (Portugal, Ireland, Italy, Greece and Spain) out of the eurozone, it is France that then begins to look fairly porcine compared to Germany and friends.
“Any splintering of the eurozone may well put France in the position of a peripheral state in a shrunken German-dominated eurozone,” Skidelsky reminds.
But it is the politics of such an option that are far more important.
The origins, the very purpose, the beating heart of the European project has always been to tie eternally warring France and Germany together.
France economically cannot ride off into the sunset with Germany and a new deutschmark, but politically, it it is even more unthinkable for her to leave and make common cause in any peripheral union.
“France has no choice but to stick to Germany. They will hope to influence and modify the German position, but Germany is the most important country. There is no way France could join some sort of PIIGS union if these countries splinter off. For France, it is essential that it preserve its place in the core; it can’t conceive of another position outside the core of Europe.”
But the imbalance that exists between the core and the periphery would then simply be replaced by an imbalance between the two most important European states. France would become the new Greece. The core of the EU would become EU utterly unstable.
The euro is not just a part of the European project anymore, that can be calmly taken apart to be put back together again at some more propitious moment: the euro has woven itself into the fabric of the EU. If there is no eurozone, there is no EU.
It’s Germany’s choice: either a splintering of the eurozone and the end of the European Union – or a United States of Europe.
As a coda, to be very clear, this essay is not intended as the ‘anti-Bild’, or to replicate any of the dark insinuations that some inferred from the Financial Times’ cartoon-map mentioned in part I.
German working families too have not benefited as their wages have been kept down these last 15 years, and a return of the deutschmark would only see them pressed down further as the disparity between German wages, paid in superhuman currency, and eastern wages, paid in something else, grew ever more stark.
Germany has been as masochistic to its own population as it has been sadistic to those outside its borders.
We’re all – Germans and Greeks and Irish and French and the rest alike – working the night-shift in the German austerity sweatshop.
This is the fourth of a four-part in-depth look at the eurozone crisis. To read the other articles in the series, please visit the following links:
Or, if you prefer to print off and read this multi-page feature offline instead, please download a PDF version of the full article.
The series is also available as an ebook for your iPhone, iPad or Kindle.